2012 07 LIBOR in 5 mins version 1


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In response to the recent LIBOR fixing scandal, we prepared an internal knowledge sharing brief.

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2012 07 LIBOR in 5 mins version 1

  1. 1. LIBOR... in 5mins In response to the recent LIBOR fixing scandal, we prepared an internal knowledge sharing brief.www.bsgdelivers.com // @bsguk Chuka Madukwe July 2012 page 1 Version 1Unlocking potential. Accelerating performance Page 1
  2. 2. The basics The London Inter-Bank Offer Rate (LIBOR) According to the British Banker’s Association (BBA), LIBOR serves as a benchmark giving an indication of the average rate at which a leading bank can obtain unsecured funding. LIBOR is calculated daily by the BBA. Each morning, the leading banks inform the BBA the rate at which they borrowed funds the preceding evening. LIBOR is an aggregation of those rates. In other words, it an aggregated rate reflecting the rate which banks have most recently borrowed from other banks. It is used to price a number of financial instruments, both long term and short term. It’s the world’s most widely used short-term interest rate. page 2Unlocking potential. Accelerating performance Page 2
  3. 3. Other facts It is governed by the British Banker’s Association (BBA) and calculated by Thomson Reuters on their behalf. The calculation is based on 16 submissions from the large banking institutions. The highest and lowest values are removed before the average is determined. The submissions of all the participant banks are published, along with each day’s LIBOR fix. The value of the loans upon which the rates are calculated is denominated in Eurodollars. Its produced for 10 currencies. page 3Unlocking potential. Accelerating performance Page 3
  4. 4. The key driver Bank liquidity – Sometimes a bank could have an increase in its deposits in the short term, hence increased liquidity. The main outcomes of this is: – They are less likely to have a need to borrow from another bank to finance capital engagements (e.g. loans) – They could consider ‘investing’ the surplus cash with other less liquid banks in the interbank market (i.e. lend to banks in the opposite position) page 4Unlocking potential. Accelerating performance Page 4
  5. 5. Why is it important? Because it provides the reference point for the cost of borrowings of all kinds – Mortgages, Credit cards, Term Leases etc. – as they are all usually set at a few basis points above the LIBOR. It is also used to drive pricing in thousands of derivative products. Because the way it is calculated and published helps mitigate uncontrolled influence of the market by big banks (an element of game theory comes to play). page 5Unlocking potential. Accelerating performance Page 5
  6. 6. Where it get interesting There are two aspects to the Barclays LIBOR scandal. The signalling effect – Banks are not happy to show weakness by stating it will cost more than their peers to borrow as this might cause lenders to pause and cause a financial freeze. Certain fast-moving deals/transactions will struggle. – There are some disagreements on the interpretation of the conversation between the Bank of England and Bob Diamond. Either way, that conversation was all about the signalling effect and the market’s perspective of Barclays based on their submissions. Influencing the LIBOR rate is a form of intra-bank collusion with the intent to positively influence subsequent transactions in the trading day. – As the story broke, there were a number of emails from traders to the LIBOR reporting team which indicate collusion where Chinese walls should have been in place. page 6Unlocking potential. Accelerating performance Page 6
  7. 7. Contact us London Johannesburg Cape Town David Reinhardt Laura Greaves Laura Greaves Regional Delivery Manager Business Development Business Development +44 7841 947 198 +27 11 215 6666 +27 11 215 6666 david.reinhardt@bsguk.co.uk busdev@bsg.co.za busdev@bsg.co.za 230 City Road 33 Fricker Road Metropolitan Centre London Illovo Boulevard, Sandton 7 Coen Steytler Avenue EC1V 2TT 2196 8001 www.bsgdelivers.com www.bsg.co.za www.bsg.co.za @bsguk @bsgafrica @bsgafrica page 7Unlocking potential. Accelerating performance Page 7